Target Costing

You don't have to face your target to shoot it; an old trick of marksmen is to use a mirror to see the target behind them and aim over their shoulder. A cue ball doesn't have to strike a selected ball to put it in a pocket; pool players become skilled at making combination shots. And the road to the top of a steep mountain doesn't go straight up its face; road builders make it zigzag.

In a way, these facts are like business. Straightforward, direct and simple methods are sometimes unavailable or offer a poor approach. In business, net profit does not have to be determined by price minus cost. Some businesses have succeeded in taking the approach that cost is determined by subtracting profit from price.

One example belongs to Toyota, which surpassed GM in 2005 as the largest auto manufacturer in the world. It has been reported that Toyota's approach to entering the U.S. market was first to be steadfast in achieving a certain net profit margin. Second, they determined what price they had to offer in order to get Americans to buy their small import instead of more well-appointed domestic cars. Third, since the difference was the cost of the car they could offer, Toyota designed the solution accordingly. This method is known as “target costing.”

Home medical equipment providers are in a perfect environment for this alternate approach to business.

According to the December 2005 issue of HomeCare, providers responding to a survey said that at least 65 percent of their revenue comes from payers that have set the prices they will pay for products and services. One of them, Medicare, accounts for 41 percent of revenues for these providers, and 82 percent of them said they have no plan to move away from Medicare in 2006.

This means that home care is not really in a different position than Toyota when it entered the U.S. market. There is a maximum price. If an HME provider will be steadfast in achieving a certain net profit margin, he can find a way to engineer the solution he offers to meet the cost.

The first step is committing to achieving an acceptable net profit margin. That number may vary among the universe of HME business-owners, and it will likely change over time. Today, we believe that mediocre performance produces a 7 percent pre-tax net income when all product lines are considered. We also know that some providers have sustained pre-tax margins greater than 20 percent.